The Firm and Market Structures (Reading 16)

Learning Outcome Statements (LOS)

a

Describe the characteristics of perfect competition, monopolistic competition, oligopoly, and pure monopoly;

b

Explain the relationships between price, marginal revenue, marginal cost, economic profit, and the elasticity of demand under each market structure;

c     

Describe the firm’s supply function under each market structure;

d    

Describe and determine the optimal price and output for firms under each market structure;   

e  

Explain factors affecting long-run equilibrium under each market structure;

f 

Describe pricing strategy under each market structure;

g

Describe the use and limitations of concentration measures in identifying;

h

Identify the type of market structure a firm is operating within;

Formulas:

Exercise Problems:

1.      If the minimum efficient scale of a single producer is small relative to the demand for an undifferentiated good, the market structure of the producer is best described as being:

A.    an oligopoly

B.     perfect competition

C.     monopolistic competition

 Ans: B; perfect competition is characterized by the five conditions:

1.       There are a large number of potential buyers and sellers.

2.       The products offered by the sellers are virtually identical.

3.       There are few or easily surmountable barriers to entry and exit.

4.       Sellers have no market-pricing power.

5.       Non-price competition is absent.

Here, the minimum efficient scale of a single producer is small relative to the demand, and the undifferentiated good are both in the five conditions.

2.      Successful product development, advertising, and the creation of brand names are most likely to have a positive impact on the economic profit of the producer under:   

A.    a monopoly

B.     perfect competition

C.     monopolistic competition

Ans: C; the most distinctive factor in monopolistic competition is product differentiation. Suppliers differentiate their products through advertising and other non-price strategies.

A is incorrect; in a monopoly market, supplier could get a maximum profit by price setting, so the non-price strategies cannot have a positive impact on economic profit.

B is incorrect; in perfect competition, the products offered are identical, so non-price strategies are useless.

3.      The least likely reason why a firm in perfect competition is a price taker is because:

A.    buyers are well informed about prices of other firms

B.     it can set its product’s price at or above the market price

C.     it produces a very small portion of the total output of a particular good

Ans: B; it cannot set price above the market price. Since there are many close substitute for the product, the demand is perfect elastic, if the price of the product raise even a little bit, the consumer will not but it. A and C are both correct reasons.

4.      For a firm in perfect competition, as output increases the marginal revenue will most likely:

A.  increase 

B.  decrease

C.  remain constant

Ans: C; in the perfect competition, marginal revenue always equals to the price, so it will remain constant whatever the output is.

5.      First degree price discrimination is best described as pricing that allows producers to increase their economic profit while consumer surplus:

A.    increase

B.     decrease

C.     is eliminated

Ans: C; first degree discrimination is that a monopolist is able to charge each customer the highest price the customer is willing to pay. In that case, monopolist extracts the entire consumer surplus.

6.      The following equations have been developed for a company:

The profit maximizing output for this firm (in units) is closest to:

A.    7

B.     8

C.     11

Ans: A; the price maximizing situation is MC=MR. In here,

7.      Consider the following data for a firm operating in perfect competition.

The firm’s profit-maximizing output ( in units) is most likely:

A.    21

B.     23

C.     in excess of 24      

Ans: B; in perfect competition market, the profit maximizing situation is MC=P. in here,

So the firm should produce 23.

8.      Which of the following statements concerning market structure and Herfindahl-Hirschman Index (HHI) is most accurate?

A.    HHI is a useful measure of potential barriers to entry

B.     Low control over prices is characteristic of oligopolies

C.     An HHI value of 0.006 indicates that a market is highly competitive

Ans: C; the HHI value of 0.006, which is very smaller, means that the concentration of this market is low, so it is highly competitive.

A is incorrect; HHI does not take the possibility to entry into account, so it’s not a useful measure of potential barriers to entry.

B is incorrect; oligopolies have highly control over prices. 

9.      In perfectly competitive industries, what is the most likely long-run effect of a permanent decrease in demand?

A.    Price decreases

B.     Firms incur economic losses

C.     The number of firms decrease

Ans: C; a permanent decrease in demand in a perfectly competitive industry will in the short-run cause the demand curve to shift to the left, causing prices to fall. However, in the long-run, firms will leave the industry due to economic losses. As firms leave the industry, supply decreases thus increasing prices back to the equilibrium where economic profit is zero.

10.  As compared with acting independently, a group of oligopolistic companies operating with perfect cooperation will most likely experience an increase in:

A.    Both output and prices

B.     Output and a decrease in prices

C.     Prices and a decrease in output

Ans: C; as the companies agree to restrict output, market price will rise above average total cost and joint economic profits will accrue.